Will India Remain the Largest Gold Consumer in 2012?

India and China are often lumped together as drivers of the gold market. But as the World Gold Council (WGC) points out in its Gold Demand Trends report, they are two different economies driven by different factors. One of the differences is that India's ravaging appetite for the metal makes it the world's largest gold consumer. However, a recent statement from a WGC official suggests this could change.

Marcus Grubb, Managing Director of Investment at the WGC said it is likely that China will emerge as the largest gold market in the world for the first time in 2012.

The Indian market swallowed over 933 tonnes of gold in 2011, accounting for 25 percent of total coin and bar demand. While this particular category of products saw a 5 percent increase, overall year-on-year gold demand in India was down 7 percent.

There were notable differences in the strength of India's gold consumption market in 2011 compared to China's, especially in the second half of the year.

In the fourth quarter, for the first time since the first quarter of 2009, China's gold demand outpaced India's. The Indian market showed significant weakness during this period, with jewelry and investment demand falling 38 percent year-on-year.

While price volatility played a role, the rupee is considered the primary culprit. In the second half of last year, its value dropped. When this happened, gold prices, denominated in US dollars, rose by an estimated 35 percent for Indian consumers between July and November. These price increases were so drastic that October's Diwali festival, which should have been a major gold purchasing event, was not enough to produce a turnaround in demand.

Ironically, India's love affair with gold is a large part of the nation's financial problems. It is a country without a domestically mined source of supply for the metal, so obtaining it requires significant outflows of capital. There are growing concerns that consumers are essentially investing their money in assets that are considered unproductive, and therefore irrelevant to economic growth.

According to Morgan Stanley, India is the only nation in the region running an account deficit, and it has been widening.

The rupee has been in a state of recovery lately, although it closed Friday flat against the USD. This could prove positive for demand.

However, the market may also react negatively—at least in the short term—to recent actions taken by the government.

In January, India raised the import taxes on gold, shifting from a flat rate system of 300 rupees per 10 grams to a system where two percent is charged on the value of gold imported.

"Due to this import tax, gold prices have already risen and there will be some impact on demand," said Bachhraj Bamalwa, chairman of the All India Gems & Jewellery Trade Federation.

Earlier this month, the government raised the base import price for gold by 5.7 percent. The base import price sets a value for small quantities of gold carried by passengers, irrespective of the purchase price. Per this month's increase, the rate is now $556 per 10 grams, which will be subject to the two percent import tax.

These cost increases are believed to be attempts by the government to increase state revenues in order to meet fiscal deficit targets.

Meanwhile, China is the world's largest gold producer, but still imports significant amounts of the metal through Hong Kong. Last year's imports by the mainland are reported to be a record 431 tons.

Gold's role as an inflation hedge could prove to be a positive fundamental for Indian gold demand, but the same possibility exists for Chinese demand. The metal has cultural significance in both cultures, and either way they will both undoubtedly remain dominant market forces.